What is a market? Economists often talk about markets as though they are natural forces that operate independently of society and government. In this Understanding Economics video, I argue that markets are simply tools for organising exchange.
A market is any arrangement through which people buy and sell goods or services. Markets can work extremely well when there is genuine competition, people have adequate information, and buyers are able to walk away if the price or product does not suit them.
But markets are not businesses, and they are not the same thing as capitalism. Businesses produce goods and services, while markets provide a mechanism through which exchange can take place. Capitalism concerns the ownership of capital and the returns made from it.
There is also no such thing as a completely free market. Every functioning market depends upon rules governing property, contracts, money and acceptable behaviour, together with institutions capable of enforcing those rules.
The problem comes when economists assume that idealised models such as perfect competition describe the real world. Monopoly power, unequal information, external costs such as pollution, and barriers to entry can all prevent markets from producing desirable outcomes.
And some things should not be allocated according to whoever can pay the highest price, whilst essential services such as healthcare and education raise fundamentally different questions because society may decide that access should depend upon need rather than ability to pay.
Markets can be useful, but they are not the answer to every economic problem. The important questions are whether a market should exist, whether it is working, how it should be regulated and whether another way of organising economic activity would work better.
Knowing that is what Understanding Economics is all about.
This is the audio version:
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This is the transcript:
Hello, I'm Richard Murphy, and this is Understanding Economics, the series of videos that I'm making that explains economics in the way that I see it. Now, I stress this is about how I see the economy, and I do not agree with the great many other economists on how our economy works, but that is why I think this series is important. I am trying to explain how the economy really works, and I am suggesting that many of those economists don't really understand that because if they did, we wouldn't be seeing the mess we've got all around us right now.
And in this video I want to talk about something that is quite important, and widely misunderstood, and that is the question: what is a market? And this has to be understood if we're going to get the terminology right that we often use when discussing the way in which our economy works. And it's important that we know how the mechanism of a market works and when it should be used and when it's best to use another mechanism instead.
A market, and let's be clear about this, is any arrangement through which people exchange things. It can be a place, and we've all been to such things , they are called marketplaces, or it could be a website or simply a network of buyers and sellers. A price is asked for, and it is then discovered, or negotiated, by agreement, or else people walk away, and nothing is done.
That is what happens in a marketplace. Decisions are made. And the resulting prices then help decide what gets made, who makes it, and who gets it. Markets are then just tools. They're not a set of beliefs. They are a way in which people exchange goods and services to mutual advantage.
And let's be clear, markets are not businesses. A business produces goods and services to meet needs. A profit may be produced as a byproduct of doing that, but it may not be the goal of the exercise. Markets include items that are not necessarily produced with a view to profit. A market is where all those goods and services, wherever they are produced, are exchanged if that is the appropriate mechanism to do so.
Competition means a business can lose its customers, its income, and its future, so every business is safer facing less competition, but markets only work if businesses face more. There is then a conundrum here. Businesses are against competition. Markets are for competition. That means businesses and markets are not the same thing, and very often they're working in conflict with each other. We have to understand that because markets are what keep businesses on their toes.
And markets are not also about capitalism. Capitalism refers to a particular form of the private ownership of business, and it relies upon the payment of wages to workers. It puts returns to owners first and concentrates power in their interests. But big owners, especially financial investors, often own shares in many competing firms and gain when those firms do not compete. Markets then do not suit their interests.
Markets are thousands of years older than capitalism. They work, but capitalism very often seeks to undermine them. And supporting markets does not then mean supporting capitalism. It can, in fact, mean the exact opposite because it can be about reducing the concentration of power amongst business owners, whereas capitalism tries to do the exact opposite.
And I want to stress there are no free markets, even though many people, especially on the right wing of politics, like to claim there are. Every market depends on rules and the organisations that enforce them. Ownership must be defined. Promises must be enforced. Contracts are necessary. Money has to be used, and the government creates it. And law must be there to ensure that disputes are settled. All of these things are provided using mechanisms delivered by states.
A free market then is usually just a reference to a market with fewer rules, but that can lead to abuse of market power, and many of those who promote the idea of free markets have exactly that goal in mind.
The question then is not whether there should be rules. There have to be; you cannot have a market without rules. That's like trying to play a game of football without having a set of rules that everybody agrees by. The question is not whether there should be rules. It is who benefits from them. Removing the rules that keep competition fair lets powerful firms take control.
And in this context, we do need to look at the misleading description of markets that many economics textbooks provide. Textbooks start with an idea of ‘perfect competition', which requires there to be many buyers and sellers in every marketplace, and for everyone to be fully informed as to all the products that are available within the market and the prices that are being asked for them. And there must be ease of entry and exit from the market so that everybody can have access to the capital required if that is necessary for them to take part. And identical products must be traded so they can be substituted one for the other, so that prices are the only variation between different buyers and sellers.
Now, real markets are almost never like this. Almost all of those conditions are entirely artificial. They will never be replicated in the real world in any situation that you will come across. Dominant firms, barriers to newcomers, and one side knowing more than the other are decidedly commonplace in most of the markets in which we deal, and we all know it from personal experience.
Models simplify, and economic models have a benefit. I'm not disputing that. But the problem with this model of markets is that it is treated as reality and policy is built on the basis of it, and it's not true. And we have seen the disasters that follow. The UK water industry is regulated on the basis that this model of a market actually works. Of course it doesn't. There is no market for water in the UK. It is an essential product. It is supplied by a few companies, and we have no choice about which one will supply us. And yet it is assumed that there is perfect competition in operation. And that is complete and utter nonsense.
And the reality is that markets can work, but they can only work when competition is real, people are well informed, and they can choose not to buy. In other words, they can afford to walk away and still meet their needs. And that is critical because there are some things that people cannot afford, but which they do need to buy, and which markets can deny to them as a consequence of their inability to pay. And so we have to understand that that is a problem that markets can create.
When markets do work, and I stress they can, prices do pass useful information between millions of people who will never meet, and we can all see that. We all trade online now. We all go to shops where we can make decisions, and sometimes we can go to another one and make an alternative decision instead. And nobody has to plan any of these things or determine outcomes for us. When that happens, it is a genuine strength of markets. We do get better social outcomes, and so markets are not inherently bad. I wish to make that point very strongly.
The question is not whether exchange happens then, but whether the conditions exist for markets to work well. That is the vital point I'm making.
And markets can fail. Markets fail when monopoly replaces competition with power, and we can see this in many parts of our economy at present. I've already mentioned water, but this is a problem with regard to the supply of electricity and other utilities. It is a problem with our supermarkets, of which there are too few to prevent what looks like monopoly power being in place, and there are other problems as well.
Some costs, like pollution, fall on people outside the process of exchange, which is negotiated within the marketplace. We get misstated prices. We have a problem which economists call that of externalities. Somebody else picks up the cost, and the person in the market doesn't pay the true price for whatever they consume. That is a market failure.
And another market failure arises when one of the people in the marketplace has more information about the product they're selling than the other one. This invariably is that the producer knows more than the buyer, and then abuse can happen.
What is more, there is a problem that I've already hinted at. In some markets, particularly when there is a shortage of supply, as, for example, there might be with regard to food and oil and other products in the UK, if we see the full consequences of the war that Donald Trump is pursuing unfolding, there will be people who want to go to the market and buy things, but they won't be able to do so because the market will only supply to those who are willing to pay the most for products when they are in short supply, and others will go without, even though the supply in question might be essential to them.
Markets then can fail when it comes to essential goods. And in those situations, it is up to the government to intervene, and in the Second World War, we saw the consequence of that. We had rationing because that was the only way in which market failure could be prevented, because people needed food and other essential products and services, and the government had to intervene to make sure that everybody had access to what the market could not supply.
There is, in other words, always a question to ask: which is what regulation is needed when we come to markets? Markets can't survive without regulation. The scale of regulation that they need is the question that we need to ask, and that is vital.
It's also important to understand that there are situations where markets just do not belong. Some things should not be bought and sold. Votes, justice and people are the obvious cases, but all have been violated in our history. Others can only be supplied by monopolies. So markets can sometimes never produce fair outcomes. And any society that wants to provide healthcare and education and other services according to need and not according to ability to pay, must then suspend the role of markets in these sectors, because they cannot function in those circumstances. There is no price to agree.
So the question to ask of any market is: should it exist? Is it working? How should it be governed, and what might work better? And let's be clear, markets are not the solution in every case. There are those who claim that is true, but it's simply wrong. Markets can fail, markets can compound injustice. So whilst they have merit in some situations, they are not the answer to every question inside our economy.
But markets are not a problem in themselves. They are only a problem when they're badly governed. The task is to make markets genuinely competitive when that is possible, answerable to the people they affect, and capable of serving everyone. In those situations, we can allow them to operate because they will serve well-being. If we let them operate in other situations, they may well provide abuse. It is up to us to make sure that markets work, and it is the role of government to deliver on our behalf.
This is an example of what my series on Understanding Economics is all about. We need to understand when, where, and why there must be intervention in the economy by government and others. And that is the point I'm trying to highlight. There is a whole series of these videos. There is a playlist down below. I suggest you start with the first one because these things were recorded in an approximately correct order. And if you do, I hope you will begin to Understand Economics.
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[…] corruption, governance, fair play, competition in fair markets (which is an issue I referred to in this morning's video, and which is particularly pertinent in the context of these reports), and whether a regulator, and […]
It is good to see something that has become so ‘precious’ questioned like this.
My view is similar, I think that markets have become a shop window for capital to come in whenever it feels like it and do what they want to do and disrupt markets. Markets are social as well as economic entities – this is lost on opportunists and get-rich-quick carpet baggers who call themselves ‘businessmen’. Such people are nothing but thieves backed up by a legal system
Capital usually arrives through the back door – changing ownership, making people offers they cannot refuse etc. It extracts the value and allocates it to itself, destroying competition and changes dynamics that were working for the majority. Capital is monopolistic in nature and markets are used as a stepping stone for that, and that what was socially useful is discarded under the guise of ‘efficiency’ (it usually leaves behind casualties that the state is left to deal with).
What we need is a modern Nazerene to come along and kick a few tables over and put them straight. Markets are multi-directional exchange mechanisms; modern capitalism OTOH is a one way street. As Richard points out, having been commandeered by capital in the name of freedom, markets have lost their morality.
Thanks
Very informative. Our energy market has failed so badly that it is affecting our entire economy. We are tied into high gas prices when gas doesn’t even form the majority of our energy sources, which impacts our businesses and industry, and still our leaders will not act. Is this ideology, capture, stupidity? All of the above?
It is almost total.
Might I suggest that you expand on this. I believe that when journalists, politicians et al talk about “Market Confidence” they are not referring to those in which goods are exchanged but rather those trading financial products; particularly shares, bonds and securities.
After you’ve found a lesser spotted godwit, that is.
Godwits first.
Black tailed.
You write, “Money has to be used, and the government creates it.” But I thought that almost all of the money in circulation is created by commercial banks when they lend.
Some is.
Around 40% is created by the government.
The rest is created by commercial banks under licence from the government.
You are quoting massively out of date data.
It is all down to the government in the end.
Ah, I see. Where does the data on this come from?
However, I don’t understand why commercial banks being under licence from the government means that “it is all down to the government in the end.” Private banks were under licence from the government pre-2008, but this didn’t prevent the massive private sector debt bubble, extended largely for non-economically productive purposes, that – as I understand it – was one of the main factors behind the subsequent financial crisis; and this scenario is, arguably, repeating now.
If 60% of the money is created by commercial banks, this still means that the general public is having to pay huge sums in interest so that we have enough money in circulation for a functioning economy. Wouldn’t some kind of ‘sovereign’ money system, where all money government-created, avoid this parasitic debt burden and reduce the likelihood of non-productive debt bubbles that are both another major generator of social inequality and a prime cause of instability in the financial system?
The data come from the Bank of England. Its explanation now says that around 80% of money is bank deposits created by commercial banks, although the precise proportion varies depending on definitions and the level of central bank reserves. I think it is higher.
I do not agree with your proposed solution.
Banks operate because the state grants them the extraordinary privilege of creating money when they lend, subject to regulation, capital requirements and ultimately the support of the central bank. The failure before 2008 was therefore not evidence that government had no power over bank credit. It was evidence that government failed to use that power adequately.
I am very wary of sovereign-money proposals that would remove money creation from commercial banks altogether. Someone would still have to decide who gets credit, for what purposes, on what terms, and who bears the losses when loans fail. If commercial banks cannot create money when lending, those decisions ultimately have to move somewhere else, potentially to the state.
I would rather regulate bank credit creation much more effectively, directing it away from property speculation and other unproductive purposes and towards useful economic activity.
The problem is not that banks create money. It is what we permit them to create it for.
You write, “If commercial banks cannot create money when lending, those decisions ultimately have to move somewhere else, potentially to the state.”
Why couldn’t commercial banks still make lending decisions – so we’d still have a market economy – but with central bank-created money, while those commercial decisions were also directed by government mandates, guidelines and limits? Would you regard this as being unworkable or problematic?
All money is credit-based. There is no other sort. Nor can there be. And it is all created by lending as a result. There is no other way. That is it. So either commercial banks create the credit and take the risk, or the state does. It is one or the other. Nothing else works.
On 10 July this year, you quoted – and seemed to endorse – a tweet by Steve Keen: “When the government runs a deficit, it also creates money. But that money lands in private bank accounts with no debt attached. … In the 1950s and 60s, private debt was low. Government spending put debt-free money into the economy. People spent. Growth was real.” (https://www.taxresearch.org.uk/Blog/2026/07/10/government-v-bank-money/)
So do you disagree with Steve (and, I assume, with Positive Money) on this, or is he saying here something different from what you’re saying about all money inherently being lent/credit-based?
If some form of government-created, debt-free money is possible, wouldn’t it still be commercial banks taking the risk if they were to lend that out?
I’m asking these questions in the spirit of trying to understand how our financial system might possibly be most effectively reformed to make it less structurally parasitic on people of average and low income.
Positive Money has never understood money, and all they have ever written has been profoundly confused, or just wrong. Steve would agree; I know. We do talk.
And there is no contradiction here. The confusion is over whose debt we are talking about.
When a commercial bank lends, it creates new money and simultaneously creates a debt owed by the borrower to the bank. When government spends more into the economy than it takes back in tax, the recipient acquires money without acquiring a corresponding debt to repay. That is the sense in which Steve Keen describes it as “debt-free money”. I agree with him.
Strictly speaking, however, money is always a credit relationship. Government-created money is ultimately a liability of the state, but it is not a debt owed by the person receiving it.
So I agree with Steve’s essential point. Where I differ from Positive Money is over whether commercial banks should be prevented from creating money through lending. I do not think they should. I think what matters is much tighter control over what bank-created credit is used for.
Ah, thank you Richard. I think this exchange might have helped me to see where some of my confusion and difficulty with getting my head around this could originate. It seems that there’s a debate over whether central bank-created money should be accounted for as debt or as equity. E.g. “Central bank money is still accounted for as debt, a legacy of an earlier monetary order. Treating sovereign money as equity would clarify central bank balance sheets…” (https://www.ineteconomics.org/perspectives/blog/sovereign-money-is-not-debt-why-central-bank-accounting-must-change) … Although I hope I don’t end up reading material by writers who ultimately fundamentally misunderstand money, leading me into even greater confusion!
Central bank money is conventionally recorded as a liability, but we should not assume that this makes it a debt in the ordinary sense. Nobody can demand that the Bank of England redeem a pound into something more fundamental. It can only redeem one form of sterling into another.
That is why applying conventional debt language to sovereign money can create confusion. Accounting conventions developed under earlier monetary systems have survived even though the nature of money has changed.
Your caution is sensible: when reading about money, always ask what the author thinks money actually is, who creates it, and what ultimately settles the claim. Those questions usually reveal very quickly whether the rest of the argument is worth pursuing.
But, be cautious about calling money equity. That is no more appropriate.